Competing
in
Capabilities
…some stories about growth:
1. All you need is Capital
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
3. All you need is Human Capital
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
3. All you need is Human Capital
4. All you need is Good Institutions
I want to look at the PROXIMATE causes of
differences in income per capita…
I want to look at the PROXIMATE causes of
differences in income per capita…
… not the ultimate causes.
Globalisation and History
•
•
•
•
Three Great Phases
1 Late nineteenth century
2 The Post-WWII era
3 The Current Phase
History and Theory
• From nineteenth century globalization yo
the Hecksher-Ohlin model
• The empirical success of Hecksher-Ohlin
• The O’Rourke-Williamson anaysis
History and Theory continued
• Balassa’s evidence
• The Intra-Industry Trade debate
• The rise of the Dixit-Stiglitz-Krugman
model
History and Theory continued
• So what’s going on now?
Quality and Trade : the new
literature
Motivation
• 1 Firms’ concerns
• 2 Empirical patterns in new firm level data
sets
Capabilities
d
c = ‘productivity’
u
u = ‘quality’
c
d
Capability is a pair (c, u) for each
technical trajectory (submarket)

U  (ux) z
1
Key feature:
The consumers choose products offering the best u/p
Implication: if u>v, the market share of a firm offering
u cannot be eroded to zero by any number of firms
offering v
Proposition 1
- given any configuration of
capabilities
(c1,u1), (c2,u2) . . (cn,un)
there is a lower bound in (c,u)
space below which a firm cannot
achieve positive sales at
equilibrium
(ex. Cournot equilibrium)
Competing in Capabilities
u
(Quality)
x
x
u/c = a
u/c = b
1/c (Productivity)
Fixed /Sunk costs
• Iso-elastic response of quality(beta)
• Isoelastic response of labour productivity
(gamma)
• Unit variable cost = labour cost +
materials cost
Proposition 2
Suppose one element in building
capability is the expenditure of fixed
outlays (“sunk costs”)
- Then competition in ‘capability
building’ will lead to a bound on the
number of firms ‘in the window’.
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
So what’s new?
• The model has been chosen so that prices
and qualities, and therefore productivity
and quality enter in a completely
symmetric fashion
• The key point is that unit materials cost
sets a floor to price, thus limiting the
degree to which changes in wages and
productivity can offset changes in quality
Quality vs. productivity
• Once raw materials at international prices
are an input….
• Wage adjustment can rescue poor
productivity…
• But not poor quality
Capability Threshold
uB
Quality
WB >>0
WB 0
uB
Productivity
1/cB
A Digression ….
• An extension of the model adds a second
parameter (horizontal differentiation)
• This can be further generalized to
“linkages between sub-markets”
• This extension is important in providing an
explanation for cross-industry differences
in market structure
σ
Linkages Across Submarkets
β
Effectiveness
of Capability
Building
The
Dixit/Stiglitz/Krugman
Line
The Hotelling
Line
Perfect
Competition
A Multi-Country Model
•
•
•
•
•
•
m industries ; Cobb-Douglas consumers
r of these are commodity type, many firms
m-r have n firms in each of countries A,B
Country C supplies raw material
Labour supply same in all
Capability of B firms < A firms
Capabilities, Quality and Wages
First r goods: qualities =1, Prod. 1/c=1
Remaining goods: qualities u in A, v in B
(Prod. Differs also)
W
Ls
W
Ls
L
Country A
L
Country B
A third country produces (only) an intermediate
good, a fixed number of units of which enter into
the production of all three final goods
Modelling Pre-Globalisation
• The aim is to exclude competition in
“quality” goods, while allowing A and B to
source materials from C.
• Two routes:
• (i) Partition country C
• (ii) Unify C but inhabitants are
insensitive to quality differences
Three Phases
• Phase I: Impact phase…Capabilities given
• Phase II: Transfer phase
• Phase III: Re-investment (escalation)
phase
Phase I : Impact
• There are three regimes, depending on
the size of the gap in capability
• Regime I….gap ~ 0
• Regime II…..moderate gap
• Regime III….wide gap
Relative Wages
I
wB
wA
II
III
Relative Quality
1
v
u
 Free Trade
Free Trade
UB
II
II
III
III

b (i)
b (ii)
v/u
Case (a)
v/u
Case (b)
Main substantive argument
• The case for globalisation should rest primarily
on the transfer and growth of capabilities it
induces
• A fundamental set of mechanisms are driven by
the coexistence of high capabilities and low
wages
• These mechanisms include, inter alia,
• ---self help driven by new incentives
• ---Transfers via FDI/ Supply chains, etc.